Strong corporate earnings, resilient US growth, and positive recovery signals from China are shaping investor sentiment and support for risk assets, says Gary Paulin, chief investment strategist at Northern Trust Asset Management. Speaking on the latest episode of Trader TV This Week, Paulin discusses how his recent visit to China has reinforced his confidence in China’s comeback story, driven by a technology-led growth model; he looks at how global AI-led productivity gains could reshape long-term inflation expectations and shares his views on how volatile oil prices and supply chain disruption could become a thing of the past.
Full interview below:
Josephine Gallagher – We always start off this show with some context. Set the scene for us. What will be informing your investment outlook this coming week?
Gary Paulin – Well, there’s no shortage of headlines or distractions, but I think in times like this, what we tend to do is go back to fundamentals and ask, what’s changed, and when I say fundamentals, the three key drivers that we focus on are growth, liquidity, and earnings. And in terms of growth, if you look at the major growth drivers, the US and China, the US has held up incredibly well. I think, despite what’s going on, the consumer has been resilient. Some parts of the economy, certainly those related to manufacturing, are seeing signs of acceleration, and China also has been doing very well, despite all the headwinds it’s facing. In terms of liquidity, I think we perhaps talk less about liquidity; it’s a wee bit harder to see. But again, the financial conditions are very loose. Indeed, global liquidity proxies are making all-time highs. The M2 in the US are making an all-time high, and then the third, and probably the most important, is earnings. And the earnings season, not just in the US and not just in relation to tech, has been incredibly robust, which I think has surprised a lot of people. In the US quarter growth, year over year, looks like it’s going to come in somewhere around 25% which is, which is astonishing. I mean, the last time we had anything like that was coming out of Covid. You remember we had the revenge spent. So I think that is what’s driving markets, and it’s good news for risk assets, and indeed, the way that we’ve positioned our client portfolios.
Josephine Gallagher – Understood lots to consider there. You recently came back from a trip to China, and given the prolonged challenges in the country, such as its real estate crisis, widespread structural issues, and weak consumer demand. How has that trip shaped your outlook on China’s recovery and how investable it is as a region?
Gary Paulin – It was really interesting. You know, it’s always dangerous to try to take a view of an economy from a desk and through a spreadsheet, and so to try and to avoid some of the errors of that, of that analysis, I jumped on a plane to visit clients and colleagues myself, and it was fascinating. We are quite constructive on, on, on the region. We’re overweight emerging markets, and China, obviously, is a big component of that, and I’ve had a working thesis for some time that China is transitioning from an old economy that was focused on debt and property to a newer one that’s more equity, financed and driven by technology. And what I saw there was an acceleration of some of the new but there was a lot of concern that even though the new economy was accelerating. There wasn’t enough to offset the drag from the older economy. You mentioned property, for example, what we saw was actually signs that the old economy, the drag that it caused, was starting to fade. You know, property prices were starting to stabilize. You were seeing inventory being drawn down for the first time in a long time, and critically, the long fight the Chinese government have had against deflation started to show signs of them winning. You saw producer prices inflict positively back in March for the first time in many, many months. So the prospect of the largest asset in the world, combined with the second-largest economy in the world exiting deflation has, I think, implications not just for nominal growth in China, but also for corporate profits, and therefore, by extension, to the Chinese stock market.
Josephine Gallagher – And building upon that, are you seeing these structural improvements and investment technology and innovation actually translating into foreign investment in Chinese assets?
Gary Paulin – You’re starting to, but it’s coming off a very low base, but I think it will continue to grow. What China is trying to do is reframe the narrative from, you know, making China because it’s cheaper to making China because it’s better and they’re more innovative. And you’re starting to see more foreign investment in what they consider to be the new productive forces, the technology sector. So I think that is likely to continue, if not accelerate. As it relates to the public market and to stock markets. The story’s really been about domestic flows. So two years ago, they changed some of the limitations they had on the institutions like the pension insurance sector to encourage more investment in stock markets, but they’re trying to promote sort of longer-term, more patient capital to engage with equities. And they seem that seems to have been quite successful. The driver now is to focus more on the retail investor, and there’s an enormous amount of excess savings been built up in China over the years. And if they can incentivize some of those savings to be put to work in the equity markets, that’s good news, not just for equity markets, but for growth and for productivity, and that’s where they’re really focused. And there is something like 120% of GDP currently sitting in these domestic deposits, and if inflation starts to pick up, they roll over onto lower interest rates, those returns start to get eroded a little bit by inflation. Then getting money into equity markets with tax incentives to boot could be something that provides a bid for that market over the medium to longer term. And then, of course, the foreigner who exited China. It was only two years ago, lots of our clients were viewing China as uninvestible, and we’re looking at ways to express EM exposure, excluding China. And so those sorts of conditioning don’t change overnight, so we’re really, I think, quite early. And a lot of clients I speak to are only just returning to visit China now, and what they see, like I saw, was a changed economy, one that’s transitioning from an old to a new world, and one that should increase the earnings, quality, and therefore valuation of those markets.
Josephine Gallagher – There’s also been major developments in the Chinese IPO market this year, as well as years of Stock Connect. So, how is this improving liquidity and investment in the area?
Gary Paulin – Yeah, I mean, the IPO market in Hong Kong and China is just, it’s incredibly vibrant. I mean, we probably don’t see that from here, but, I mean, there are some incredible first-day performances. But, yeah, what they’ve done is they’ve actually lowered some of the requirements to list on the exchange. I think there used to be a profit requirement, which has now been removed, which just incentivizes, you know, a lot of innovative companies to enter the public markets, to gain that liquidity to enable to grow. And so that’s really, I think, encouraging that whole ecosystem, and it’s really vibrant, but you got to see it to believe it, because, you know, sitting here in London, we don’t really, I think, sense the excitement that’s occurring on the mainland, but also in Hong Kong.
Josephine Gallagher – I’d also like to ask you a bit about what you’re seeing in terms of AI productivity, and where are you seeing the biggest potential impact in terms of, you – know, corporates, GDP, and even long-term inflation?
Gary Paulin – So I think the first thing to say about productivity its not the thing that comes first. What comes first is the investment in AI, and then the benefits and the fruits of that labour will follow. That said, we’re already seeing signs of productivity growth. Sure, it’s concentrated in some of the technology names, who, by the way, are the ones that have got most of the compute. So it’s obvious that they’ll benefit. But you know, you’re seeing record cash flow, record profits emerging for some of these companies, without any increase in headcount. So that’s productivity growth, but where I think the story lends itself most impactfully is going to be not just in how we calculate for debt and deficits going forward, because it’s hugely impactful for that, but really what it does for the prospects for long term interest rates and, by extension, what it means for the reaction function for central banks, but in particular the Federal Reserve, given they have a new Fed Chair starting, most likely in June. Now, Kevin Walsh and Scott Bessant are firmly of the view that AI is going to deliver a significant disinflationary force, which means they can run the economy hotter than they perhaps could have otherwise, and get growth without inflation. Now they keep referring to Greenspan’s 90s as the analogue, where you know that was the last time you had a non-inflationary boom driven by technology. And if that is the analogue, then that suggests market pricing still has further to run to the upside.
Josephine Gallagher – Finally, to wrap things up, what are investors overlooking? What have we missed out in this conversation?
Gary Paulin – Well, I think not focused enough on what can go right from AI. There is a lot of focus on the negative aspects and what can go wrong from AI, but questioning, for example, what AI could do to productivity, and therefore the Fed’s reaction function, is important. But the other area that I find quite curious is that there is a consensus that oil prices stay higher for longer, and so I like, would like to explore the counterfactual on that, and I’m no oil analyst, and we don’t. Forecast the oil price, but I have had my fair share of commodity booms and busts, having grown up in rural New Zealand, and they all tend to follow a similar pattern. You know, after a scarcity comes a surplus. Producers always tend to chase price. The exception to that is if there is supply discipline through, a cartel or the like. But of course, as that relates to oil prices in OPEC, now you’re starting to see that fragment. With the UAE moving out of OPEC. You’ve got GCC (Gulf Cooperation Council) states, I think, will be very eager to regain their lost revenues and their lost market share once the issues with the straits are solved. And then, of course, you’ve got Western Hemisphere countries, Argentina, Guyana and Venezuela starting to really ramp up production, and these are large areas in terms of reserves. So all that’s coming, coming at a time when decarbonisation is rebranding as a moral or an economic thing to something that’s far more strategic. And I think the imperative to increase, you know, exposure to renewables is only going one way, and that’s up. And then finally, what this episode has shown is the ability of the world to quickly adapt and to diversify supply chain, such that the strategic hold that the straits had at the beginning of this war, roughly 20% of global supply may no longer be that large. So that threat has been eroded, and I think that has an implication for price. So again, not taking a view on the oil price, but what I do, and what I would challenge, is this idea that oil prices stay higher for longer. If you look at commodity cycles, they generally, they tend to when you know, when you see a scarcity, the surplus tends to follow,
